Last updated: 23/07/2020 | Estimated Reading Time: 3 minutes
Mortgage interest rates
When you take out a mortgage to purchase a property, the amount you have to pay back will consist of the value of the loan plus any interest charged during its term.
There are various ways in which this interest might be charged, and various ways in which the rate of interest is calculated. We’ll go through all of this over the course of this guide.
In This Guide:
How are interest rates worked out?
Interest rates offered by mortgage lenders are calculated according to a variety of factors.
First, we’ll have a look at how mortgage providers work out what is known as their ‘headline’ or representative rates – that is, the rates you’ll see advertised.
Then we’ll have a look at how your lender will calculate the rates you’re actually offered, based more on your personal financial situation.
The main drive behind the headline rates of interest is the Bank of England’s base rate which is essentially the cost of money as set by the state bank.
Also taken into account is the London Interbank Offered Rate (LIBOR) which is the average rate at which banks borrow money from each other.
Once these national rates have been considered, the lenders will look at things like the unemployment rate at the time and also the number of repossessions, both of which help them work out the risk associated with lending.
The actual rate you are offered personally will differ somewhat from the advertised representative rates depending on your financial health at the time.
Your credit history is very important at this stage – having a better credit rating will mean that you’re offered much better interest rates, all other things being equal.
The rate you’re offered will also change depending on the loan-to-value (LTV) ratio associated with your mortgage. The LTV is the difference between the size of your mortgage and the overall value of your property, where the remainder is paid as a deposit.
So for example: if you want to buy a property worth £400,000, and you can afford to pay a deposit of £80,000 and therefore take out a mortgage worth £320,000, your LTV will be 80%.
Essentially, the lower your LTV, and so the higher your deposit, the better interest rates you’ll be offered.
Interest rates and types of mortgage
There are three different types of mortgage available when it comes to interest being worked out. We’ll go through each of them now:
Fixed Rate Mortgages
With a fixed rate mortgage, the interest rate stays the same for a set period (generally two to five years). This means that you can be certain that for the duration of the set term, you’ll know exactly how much you’ll be paying each month, allowing you to budget well into the future.
You’ll also be protected should interest rates rise over the course of your set term, though if they go down you’ll end up paying slightly over the odds.
Variable Rate Mortgages
The interest rate attached to a variable rate mortgage is charged at the lender’s standard variable rate (SVR). This is subject to change regularly and at the lender’s discretion.
Tracker mortgages, as the name would suggest, directly track the Bank of England base rate in order to calculate the interest charged. The rate will stay a set percentage above the base rate, usually around 0.5-2%.
Whichever kind of mortgage you’re after, we can help you find the best mortgage deals with the lowest interest rates. Just head over to our mortgage comparison page and see what kind of representative rates are on offer so that you can get borrowing right away.